Real Estate Hedge Funds Versus Direct Investment: Which Option Should I Choose?

When it comes to investing in real estate, there are a number of ways to participate in the industry, including through hedge funds, real estate investment trusts, and direct investments. However, directly investing in real estate or employing the services of hedge funds has proven to be two of the most popular and best available options.

In this article, we’ll explore both options, how they differ from each other, and choosing where to invest.

Differences Between Direct Investments And Hedge Funds

As the name suggests, in a direct real estate investment, you purchase a property, such as a residential building or shopping center. You are directly involved in all the processes, and you make your money through rental income, profits generated from activities that depend on the property, and appreciation. On the flip side, you are not involved in any of the backend stuff when you invest in hedge funds. The real estate hedge fund pools capital from several investors before making an investment in real estate investment trusts (REITs), properties, or other real estate-related stocks. It is quite common for real estate hedge funds to invest in REITs.

Investing in a hedge fund makes it possible for you to invest in multiple properties, and with a lesser amount of money than it would take to outrightly buy a property. This is perhaps the biggest advantage hedge funds have over direct investment – the ability to access profits from the real estate industry without needing to own, operate or directly finance properties. You can invest in a real estate hedge fund with as little as $500. Meanwhile, $500 may not even be enough to rent an apartment in a month. However, there are some tradeoffs to investing in hedge funds over going the direct route.

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For one, directly investing in physical properties has the potential to generate substantial cash flow. This is in addition to the numerous tax breaks you can access to offset the income. For instance, you can deduct the maintenance costs of the property, as well as deduct the costs of improving the property over its useful life (depreciation). Secondly, the prices of properties generally increase with time, so you may be able to resell the property at a much higher price later.

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To wrap up this section, the biggest difference between both options is perhaps the fact that you get to pay performance and management fees to the hedge fund. There are no such fees in the direct investment option. However, it requires a significant amount of time and energy if you want to be successful. You could opt to hire the services of a property management firm though.

Choosing Where To Invest

Your budget plays an important role in which of the two options you eventually settle for. For instance, you will only be able to invest in REITs if all you have is say $1,000. In this case, while you have the freedom to pick the hedge fund you do business with, you cannot choose what the fund invests in.

Direct real estate investment gives you total control over your decision-making. For example, you might want to invest in the Toronto market because it is picking steam. You have the freedom to select the location, property type, rental prices, tenants, and financing structure. By employing the services of a property management company in Toronto you can enjoy this freedom without living in the area. This makes direct investments nearly as passive as buying into hedge funds.

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How To Invest In Rental Property

Although a hedge fund may be your best bet if you are on a tight budget or don’t have the time to do all the background work, you still have to research the fund managers’ track records. If your goal is to own a property, then you’ll have a lot more work cut out for you. Instead of researching fund managers, you will be assessing different real estate markets to find the best opportunity. And if you don’t have enough capital to buy a property, you could seek finance from hard money lenders, private money lenders, seller financing, or peer-to-peer lending.

It is worth mentioning that to invest in traditional hedge funds as an individual, you must be an institutional investor, like an accredited investor or a pension fund. Accredited investors have an annual individual income of over $200,000 ($300,000 if married) or a net worth of at least $1 million excluding the value of their primary residence.

Overall, there are plenty of opportunities when it comes to investing in real estate. The industry is primed for a massive comeback as the effects of the global pandemic winds down. While direct real estate investment may be a preferable option if you have the capital and want more control over your investments, a hedge fund will make sense if you do not want to operate or manage real estate.

Image by Bárbara Cascão from Pixabay

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